Taxes 2011 – 10 Tips to Avoid an Audit

Take it from someone who’s been there: An IRS audit is no walk in the park.

My first (and hopefully last) office audit was more than 20 years ago. I’ll never forget the letter the accountant I hired to represent me – also a personal friend – sent me. It said, in part: “Don’t worry – we’ll fight this to your last dollar.”

If memory serves, I came out of my audit unscathed. But it’s like going to the dentist: Even if you don’t have any cavities, it’s still nothing resembling a good time.

You’ll see any number of articles suggesting that there’s a path you can take that will ensure you’ll slip by unnoticed. There isn’t. Nobody outside of the agency really knows why or how the IRS picks returns for further study. Like Coca-Cola, the formula is a secret. In addition, some returns are chosen randomly, so even if you had the inside scoop, you could still end up in audit-city.

There are, however, past patterns, statements from the agency and other direct and indirect indications of potential audit triggers. So while there’s no set of instructions guaranteed to keep the tax man away, there are things you can do to try to minimize your odds.

The first three are in the following video – check it out, then meet me on the other side for more.

To recap those tips, three things to avoid are using a preparer that’s on the IRS’s radar, claiming hobby expenses as business deductions, and claiming any kind of deductions that are large relative to your income. But, as I said in that story, if you’re entitled to a deduction, by all means, take it. Just be prepared to prove your case should your return be flagged.

Now, let’s look at some other things that might draw the eye of the IRS…

7 more things you can do to minimize your audit odds

1. Don’t make mistakes on your return. We did a post a couple of weeks ago called Avoiding 13 Common Mistakes, so I won’t repeat them here. But it’s common sense to assume that the more mistakes you make, the more your return will stick out. So make sure your math is right, your return is signed, your Social Security number is correct, yada, yada, yada.

2. Don’t be a millionaire. Just kidding, of course: Being rich is always a good idea. But reporting a high income will make you more likely to get audited. From a story I wrote last year called What Are Your Odds of an IRS Audit?:

  • If you made under $200,000 last year, your odds of an audit are about 1 percent.
  • Incomes over $200,000 but less than $1 million had audit odds of nearly 3 percent.
  • With an income over $1 million, your odds of an audit increase to nearly 6.5 percent.

You don’t have to be a rocket scientist to figure out that Uncle Sam needs money, and the best place to find it is to visit with people that have some.

3. Don’t claim the earned income tax credit. Again, just kidding – if you qualify for this credit, you definitely want to take it. According to this page of the IRS website, last year more than 26 million people received nearly $59 billion from the EITC. What the credit does is provide up to $5,666 to low-income tax payers. And it’s refundable: That means you can get a check even if you didn’t pay any taxes.

Since this credit is potentially big, widespread, and refundable, it’s also a source of scrutiny. According to this IRS report, for fiscal year 2002, EITC audits recovered $850 million, and 48 preparers and 137 other people were criminally convicted of income tax fraud for EITC schemes. So if you take this credit, make sure you properly compute it.

4. Don’t file a Schedule C. Schedule C is how many self-employed people claim deductions for their small businesses. But it’s also an area so rife with overstated deductions that in 2009 the U.S. General Accountability Office put out a study called Limiting Sole Proprietor Loss Deductions Could Improve Compliance. From that report:

According to IRS estimates last made for 2001, 70 percent of the sole proprietor tax returns reporting losses had losses that were either fully or partially noncompliant.

How do you avoid what is obviously an area of IRS concern? Don’t file a Schedule C – incorporate your business and file as a corporation. Of course, forming a corporation isn’t free, and filing a corporate tax return can be trickier than filing an individual one. But if you decide to stick with a Schedule C, be prepared to back up your deductions, especially if your business is reporting a loss.

5. Report all of your income. As we recently said in the story Are We a Nation of Cheaters?, everything you make is theoretically taxable income, whether it’s reported to the IRS or not. But while you may get away with not reporting the $50 you won at poker last week, you’d best report everything you received from employment or investment activity.

IRS computers now compare nearly 100 percent of the forms submitted by income payers to the tax returns of income receivers. If your employer didn’t send you a W-2, or you didn’t get the a 1099 from your bank, that doesn’t mean they didn’t report it.

6. E-file. In the early days of electronic filing, there was a rumor that e-filed returns were more likely to get audited. That was never true, but now the IRS is virtually saying the opposite: Handwritten returns are more likely to contain errors, and invite unwanted attention. From this 2010 press release…

Other e-file benefits include a reduced error rate (1 percent compared to nearly 20 percent on a paper return), which means a decreased likelihood of hearing from the IRS.

7. Prepare an accurate state tax return. As I found out when I got audited, federal and state taxing authorities stay in touch. If your Federal return is audited, the state folks are notified – this is also true in reverse.

Bottom line? Be cautious, but not paranoid

As you read articles like this one, it’s easy to convince yourself that one slip of the mouse could result in a prison term. But the truth is that the IRS isn’t all that hard to deal with. Relatively few audits are in-depth and even fewer are in person. If your return is flagged, odds are you’ll simply get a note in the mail asking for further explanation. For example, if you forget to report some interest income, a field agent isn’t going to show up at your door: You’re just going to get a letter explaining the discrepancy and asking for more information.

Always take whatever deductions you’ve got coming. Just keep good backup, then store that backup, along with your returns, for at least three years – the normal audit limit.

But remember, if an examination reveals you’ve under-reported your income by 25 percent or more, the IRS can go back six years. And if they find fraud? If they feel like it, they can go all the way back to the first return you ever filed – or forgot to file.

Disclosure: The information you read here is always objective. However, we sometimes receive compensation when you click links within our stories.

Read Next
3 Ways a Health Savings Account Can Improve Your Finances
3 Ways a Health Savings Account Can Improve Your Finances

Open an HSA in minutes to help you save on taxes, cover medical expenses and grow your retirement nest egg.

14 Things We Buy and Then Almost Never Use
14 Things We Buy and Then Almost Never Use

Save your money. These items seem alluring but they often end up as coat racks and dust magnets.

10 Things That Really Are Free on Amazon
10 Things That Really Are Free on Amazon

These freebies are available to anyone — no Prime membership necessary.

8 Ways to Slash the Cost of Homeowners Insurance
8 Ways to Slash the Cost of Homeowners Insurance

Reviewing this critical insurance policy takes a little effort, but it pays off big.

These Are the 4 Best Medicare Advantage Plans for 2020
These Are the 4 Best Medicare Advantage Plans for 2020

Medicare Advantage customers themselves rate these plans highest.

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Most Popular
9 Things You’ll Never See at Costco Again
9 Things You’ll Never See at Costco Again

The warehouse store offers an enormous selection, but these products aren’t coming back.

11 Things Retirees Should Always Buy at Costco
11 Things Retirees Should Always Buy at Costco

This leader in bulk shopping is a great place to find discounts in the fixed-income years.

Over 50? The CDC Says You Need These 4 Vaccines
Over 50? The CDC Says You Need These 4 Vaccines

Fall is the time to schedule vaccines that can keep you healthy — and even save your life.

11 Household Items That Go Bad — or Become Dangerous
11 Household Items That Go Bad — or Become Dangerous

When you get the impulse to stockpile these everyday items, pay close attention to their expiration dates.

8 Things You Can Get for Free at Pharmacies
8 Things You Can Get for Free at Pharmacies

In this age of higher-priced drugs and complex health care systems, a trip to the pharmacy can spark worry. Freebies sure do help.

7 Ways to Boost Your Credit Score Fast
7 Ways to Boost Your Credit Score Fast

Your financial security might soon depend upon the strength of your credit score.

The 10 Most Commonly Stolen Vehicles in America
The 10 Most Commonly Stolen Vehicles in America

A new model parks atop the list of vehicles that thieves love to pilfer.

This Is the Cheapest Place to Buy a Used Car
This Is the Cheapest Place to Buy a Used Car

Looking for a good deal on a set of wheels? This should be your first stop.

19 High-Paying Jobs You Can Get With a 2-Year Degree
19 High-Paying Jobs You Can Get With a 2-Year Degree

These jobs pay more than the typical job in the U.S. — and no bachelor’s degree is required.

The 15 Worst States for Retirees in 2020
The 15 Worst States for Retirees in 2020

Based on dozens of metrics tied to affordability, quality of life and health care, these are not ideal places to spend retirement.

9 Deep Discounts Available on Amazon This Friday
9 Deep Discounts Available on Amazon This Friday

These items are all steeply discounted — but the deals won’t last long.

11 Senior Discounts for Anyone Age 55 or Older
11 Senior Discounts for Anyone Age 55 or Older

There is no need to wait until you’re 65 to take advantage of so-called “senior” discounts.

5 Ways to Get Amazon Prime for Free
5 Ways to Get Amazon Prime for Free

Hesitant to drop $119 a year on an Amazon Prime membership? Here’s how to get it for free.

26 States That Do Not Tax Social Security Income
26 States That Do Not Tax Social Security Income

These states won’t tax any of your Social Security income — and in some cases, other types of retirement income.

10 Reasons Why You Should Actually Retire at 62
10 Reasons Why You Should Actually Retire at 62

If you can, here are several good reasons to retire earlier than we’re told to.

3 Ways to Get Microsoft Office for Free
3 Ways to Get Microsoft Office for Free

With a little ingenuity, you can cut Office costs to zero.

5 Keys to Making Your Car Last for 200,000 Miles
5 Keys to Making Your Car Last for 200,000 Miles

Pushing your car to 200,000 miles — and beyond — can save you piles of cash. Here’s how to get there.

7 Surprising Features That Boost Your Home Value
7 Surprising Features That Boost Your Home Value

You can add value to your home without hiring a contractor to do expensive renovations.

5 Things That Make Life More Meaningful for Retirees
5 Things That Make Life More Meaningful for Retirees

Retirees agree: These are the things that give them purpose and fulfillment in their golden years.

View More Articles

View this page without ads

Help us produce more money-saving articles and videos by subscribing to a membership.

Get Started

Add a Comment

Our Policy: We welcome relevant and respectful comments in order to foster healthy and informative discussions. All other comments may be removed. Comments with links are automatically held for moderation.